The most important thing when selling all or part of a business, is the valuation to which the parties come to when consummating a transaction. This is often the biggest hang-up when trying to close a deal. Other factors such as timing, structure, growth rate, personnel, and financial performance are also important factors that play into making an investment into a business. We have narrowed this blog article to the art of valuing other people's companies, and some important key factors that play into arriving at a number everyone can agree with. It is important to note, that this is just our quick guidelines that we use at Grand Rapids Venture Capital (GRVC). As the old adage goes, "a business is worth what someone is willing to pay for it."
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is a universal number that signifies the business income, prior to those other factors. This is usually the number that valuation firms, investment banks, private equity and other funds use as a basis for the valuation. Although many company's financials track this already, making sure those numbers are accurate is essential in ensuring an accurate number. Many asset heavy companies will show a much higher EBITDA versus their Net Income number, because of their Depreciation expense. Another factor that could influence a lower EBITDA is Capital Expenditures (CAPEX) or one-time expenses that reduce the bottom-line but should be added back into the EBITDA number. Determining what these CAPEX items were is important for both parties.
Determining a Multiple
After establishing an EBITDA through some initial financial due diligence, the parties then need to determine a multiple of earnings. Normally businesses of any size (over $150k in EBITDA) will be valued at EBITDA times a multiplier. This is the objective piece of the valuation puzzle. The buying party always wants to have a smaller multiplier while the seller is fighting to raise the multiple as high as they can. Some of the factors listed below help determine the multiple:
- YOY Top & Bottom Line Growth Percentage
- Industry and Type of Business (retail, distribution, manufacturing, technology)
- Age of the business
- Market Conditions
- Personell Transition
There are many more things that go into this multiple, but these are the significant items to consider. One of the most important is the Industry the business is in. Typically, retail businesses will fetch the lowest multiple due to the difficulties in operating the business and the risk associated with it. Technology and franchise companies have been seeing higher multiples due to the ability for the business to scale and grow quickly in a short period of time. In addition, many of those businesses are established with the understanding of a growth-first business rather than income producing.
How the business is funded is a very important factor for both parties in the valuation process. How much equity is being sold, how much seller-financing is given and how much cash is the company going to have to pay up-front. The higher the cash investment and equity being sold, the lower the multiple, normally. The best way for a seller to get a larger multiple in this category is to "bet on themselves" and provide more seller financing.
Although this is a framework for valuing a business, there are several scenarios where this doesn't apply. Within GR Venture Capital's target acquisition profile, this is a good start to establishing a range to continue further discovery and discussions on potential acquisitions / investments. We hope this was helpful and if you have an idea, business or are an investor, do not hesitate to reach out to us. We always love to extend our network and discuss new opportunity!